The looming so-called crisis facing the US after the reelection of Barack Obama is the fiscal cliff. It has been hyped as something that will bring wrack and ruin to the US economy unless something is done soon to prevent it from happening.

However, in my opinion and that of others, if nothing were done and the provisions already agreed upon went into effect on January 1, 2013, it might actually turn out to be the best thing for the US in the long run, mainly because the military-industrial complex would take a hit while there would be no consequences for Social Security, Medicare and Veteran benefits.

And it is not exactly what I’d call a big hit for defense. In 2011 the defense budget was $712 billion – larger than the rest of the world’s military budgets combined. The ‘fiscal cliff’ would just mean that the military budget would be $55 billion (or 8%) less in 2013 so what’s the big deal especially with two wars coming to an end? Where’s the peace dividend in all this? Evidently, nowhere if defense contractors have anything to say about it. The fiscal cliff also provides that defense and non-defense discretionary spending increases from 2013-2021 would be about 1.5% annually, a good thing I’d say.

The other great things about letting the fiscal cliff just happen is that it would represent a relatively big tax increase on the rich and a lowering of the deficit – two of Obama’s campaign pledges. So Obama could reduce the deficit and raise taxes on the rich just by doing nothing – no negotiations with obstructionist Republicans, no time wasted with John Boehner, no excuses for selling out to his base. It would be a glorious exercise of Presidential power and then he could get on with other business.

Here’s the deal on the tax increases. Taxes would go back to what they were under Clinton. Since the Bush tax cuts gave paltry reductions to the middle class and huge reductions to the rich, repealing the Bush tax cuts would mean a paltry increase for the middle class and a huge increase for the rich. That’s why Boehner wants to “reform the tax code and eliminate loopholes.” This is code for “let’s increase taxes in such a way that the middle class not the rich takes most of the brunt.”

The problem with lowering tax rates and eliminating loopholes is that the lowered rates will remain permanent, a big boon to the wealthy, while eliminating loopholes will be temporary because lobbyists for the rich will go right to work drilling new loopholes as they did after the “tax reform” in the 1980s. Except the middle class loopholes like the mortgage deduction would remain permanent.

In an op-ed in the New York Times, Nobel winning economist Paul Krugman said, “So what should [Obama] do? Just say no, and go over the cliff if necessary.” First of all, as others have pointed out, it’s more like a hill than a cliff. Second, the advantages outweigh the disadvantages especially if Obama would have to negotiate away the very positive results of doing nothing: 1) a transfer of funds away from the military-industrial complex, (2) going a long way to solve the deficit problem and getting our fiscal house in order, (3) raising taxes on the rich relatively more than on the middle class and (4) reversing the growing economic inequality between the rich and everybody else.

Republicans are using the scare tactic of threatening that letting the fiscal cliff happen will return the economy to recession. The so-called fiscal cliff is actually a good deal for most Americans except for the very wealthy and the military-industrial complex. The outcome of negotiations to forestall the fiscal cliff could actually turn out to be a worse deal for the middle class if Obama isn’t careful. He has the stronger bargaining position politically because he doesn’t have to run for reelection and the fiscal cliff itself actually mostly favors Democratic principles.

But count on the Republicans not to be in a conciliatory mood. Boehner has already indicated that his idea of resolving the fiscal cliff crisis is to not raise taxes on the rich. First of all, their logic is flawed. A tax increase on a successful business is not going to cause layoffs in that business if demand for product is steady or increasing.

Second, the employed middle class is going to continue to consume (70% of GDP is consumption) albeit at a slightly lesser rate (a good thing as we discuss later). The concern should be with the already unemployed and marginally employed and the economically vulnerable, but the so-called fiscal cliff doesn’t affect them one way or the other. Tax increases on the already employed will be of no major economic consequence or hardship.

The biggest threat is that the economy will go into recession because Lockheed Martin will lose a lot of jobs. But so what? If the size of the military-industrial complex is ever to be reduced, it means loss of jobs in the military-industrial complex. It’s as simple as that.

There is no political downside for President Obama. He doesn’t have to stand for election again. Even if the economy goes into recession temporarily, it will all but be forgotten four years from now especially if the deficit has been reduced and the rich are finally paying their fair share. If there’s to be any pain let it happen at the start of a term, not the end.

Letting the fiscal cliff happen will accomplish several of President Obama’s objectives without him even having to break a sweat. Then he can get on with further accomplishments to add to his legacy. He will be on a roll. He has nothing to lose and everything to gain without negotiating with Boehner and the Republicans. To the extent he negotiates at all, it should be to accomplish his remaining objectives: a huge infrastructure bill to put displaced defense workers and others back to work in the peace industry rather than the war industry and extended unemployment insurance (something taken away by the fiscal cliff).

Letting the fiscal cliff happen will finally do something about growing inequality in the US. The latest data show the top 1 percent garnering 93 percent of all the gains from the recovery so far. But median family income is 8 percent lower than it was in 2000, adjusted for inflation. The richest 400 Americans now have more wealth than the bottom 150 million of us put together. Political equality is being sacrificed to economic inequality.

In an excellent book, “Winner-Take-All Politics, How Washington Made the Rich Richer and Turned Its Back on the Middle Class” Hacker and Pierson demonstrate that the average after tax income of the richest 1% rose from $337,100 in 1979 to more than $1.2 million in 2006 – an increase of nearly 260%. Meanwhile, average take home pay for the majority of Americans has remained stagnant for 30 years. And this wasn’t due to the fact that the super rich are better educated than the rest of us. It’s due to the fact that they and their lobbyists have curried favor with Washington politicians and turned the levers of political power to favor their increased economic power largely through an advantageous tax code. It’s more crony capitalism than laissez-faire capitalism.

The conventional wisdom is that we can’t tolerate another recession. The truth is that we’re not only addicted to debt, we’re addicted to consumption. We’re addicted to the fact that growing GDP is the answer to all our problems.

It isn’t. Since consumption in the US represents 70% of GDP, if people stopped consuming at the present rate, it would mean a diminution in GDP possibly even a recession, but at the same time the American people might be better off. Here’s an example. A significant part of GDP is made up by sales at fast food and pizza restaurants. If people cut their consumption of these foods by 50% the economy might go into recession, but the American people would be far healthier.

Health care (really it’s sickness care) is 17% of the economy. If Americans cut their consumption of unhealthy foods and started exercising, sickness care costs might be reduced to 8% of GDP. This would put the US economy into recession while at the same time the average American would be better off. If Americans stopped going to casinos and gambling, they would be individually better off while GDP would decrease as would the profits of billionaire casino moguls Sheldon Adelson and Donald Trump who tried to buy the Presidential election for Mitt Romney.

There are all sorts of reasons why reducing GDP, even if it meant a recession, might also mean that the American people would be better off. For instance, if I pay you $50. to mow my lawn, and you pay me $50, to mow your lawn, GDP has increased by $100. If we both mow our own lawns, GDP does not increase at all. In general if people do more for themselves and their families rather than paying someone or some corporation for equivalent goods and services, GDP will decrease.

The average person, however, will be better off if they save their money and pay down their debts rather than increasing or maintaining their consumption levels. If we go from a cash economy to a do-it-yourself economy we will be better off even if GDP and corporate profits decrease. When we participate in the cash economy most of the profits go to large corporations and are siphoned off from local communities.

Unfortunately, the US economy is addicted to GDP growth as well as debt. Changing priorities and buying habits could result in consumption coming down from 70% of GDP to say, perhaps 60%. Would this throw the economy into technical recession? You bet it would. Would it be better for American families. You bet it would. They would be better off if they readjusted their priorities and became less dependent on consumption and more inclined to produce locally for their own needs instead of purchasing everything at Wal-Mart. However, corporate profits and Wall Street would suffer. Too bad.

Let’s give Paul Krugman the last words of wisdom:

“And the looming combination of tax increases and spending cuts looks easily large enough to push America back into recession…”Nobody wants to see that happen. Yet it may happen all the same, and Mr. Obama has to be willing to let it happen if necessary.”

“Why? Because Republicans are trying, for the third time since he took office, to use economic blackmail to achieve a goal they lack the votes to achieve through the normal legislative process. In particular, they want to extend the Bush tax cuts for the wealthy, even though the nation can’t afford to make those tax cuts permanent and the public believes that taxes on the rich should go up — and they’re threatening to block any deal on anything else unless they get their way. So they are, in effect, threatening to tank the economy unless their demands are met.

“Mr. Obama essentially surrendered in the face of similar tactics at the end of 2010, extending low taxes on the rich for two more years. He made significant concessions again in 2011, when Republicans threatened to create financial chaos by refusing to raise the debt ceiling. And the current potential crisis is the legacy of those past concessions.

“Well, this has to stop — unless we want hostage-taking, the threat of making the nation ungovernable, to become a standard part of our political process.”

John Lawrence

John Lawrence graduated from Georgia Tech, Stanford and University of California at San Diego. While at UCSD, he was one of the original writer/workers on the San Diego Free Press in the late 1960s. He founded the San Diego Jazz Society in 1984 which had grants from the San Diego Commission for Arts and Culture and presented both local and nationally known jazz artists. John received a Society of Professional Journalists, San Diego chapter, 2014 award. His website is Social Choice and Beyond which exemplifies his interest in Economic Democracy. His book is East West Synthesis. He also blogs at Will Blog For Food. He can be reached at j.c.lawrence@cox.net.

Comments

Our current tax and trade tariff rates and laws encourage outsourcing of jobs and hording of wealth.
What a shame that our country has been brainwashed into thinking that lower taxes equals better jobs and opportunity when actually quite the opposite is true as we look back on history. High trade tariffs and high top marginal income tax rates along with higher capital gains tax rates are what helped the USA economy in the fifties, sixties, and seventies. Back when tax rates encouraged the wealthy to shelter a good portion of their returns back into the company in the form of jobs, pay raises, and expansion instead of pocketing the profits in a Cayman account. Back when import tariff taxes made it unprofitable to exploit slave wage manufacturing overseas because the products produced would be too costly as they crossed our borders.

11:29 AM EST
The guests and George intelligently discussing, debating, and informing Americans about the economic realities of the so-called ‘Fiscal Cliff’ on ABC were surprising — not so much from their outstanding lack of economic knowledge, but from a surprising truth offered accidentally by the young Republican Rep from Illinois, Aaron Schock when he proclaimed that the math doesn’t work and that taxing the rich will not solve the deficit problem, nor allow the investment in our future that all citizens and both parties want.

Yes, Aaron, “taxing” the rich (on their income) won’t solve the scare of the ‘Fiscal Cliff’ —– but the way to solve the ‘Fiscal Cliff’ and also fund education, investments, and both capital and human resources for our society’s future growth, health, and prosperity can be achieved through the simple step of ‘Wealth Reform’ — as similar to the proven success of ‘Land Reform’ in many countries whose asset (land) was being monopolized, horded, and taken out of constructive use by an entrenched and tiny (1%) elite of wealthy land owners.

In our country, the entrenched 1% elite have taken the wealth of the country, the commonwealth, out of constructive use and are holding and hording it (as even FOX and CNBC business talking heads admit, “There’s trillions on the sidelines”), and this essential and potentially ‘game changing’ opportunity for investment in human and other resources is being sequestered by a financially blocking elite who are only interested in being a unearned income, ‘rentier’ class — just as the landed elites were in many other crushed and stagnated countries.

So, Aaron, you are a genius (possibly without knowing it), by pointing out that taxing the income of the rich is not enough (since most is at low rates like carried interest already).

What Obama needs to do to unlock the potential for our country is to use a bold program of “Wealth Reform” — particularly since the US has the highest GINI Coefficient of Wealth Inequality (0.80) in the entire world, which will make the politics of such such a “Wealth Reform” – “Program for Progress” in the US very popular with 99% of the CITIZENS.

Even the Corporatist Media will have to report that Obama is
considering “Wealth Reform” to address the ‘Fiscal Cliff’
and hell, just raising the specter of “Wealth Reform” will
have the wealthy begging for any other solution.

Let’s not forget about the capital gains tax which taxes mainly the wealthy which was nearly 30% during the Clinton administration and then was halved to 15% under George W Bush. It’s not all about income taxes by a long shot. Raising it back to 30% and closing the “carried interest” loophole will be a huge boost towards reducing the deficit and generating funds to do infrastructure repair and improvement.

John- here’s my biggest take-away from your excellent article “The problem with lowering tax rates and eliminating loopholes is that the lowered rates will remain permanent, a big boon to the wealthy, while eliminating loopholes will be temporary because lobbyists for the rich will go right to work drilling new loopholes as they did after the “tax reform” in the 1980s.”
The left needs to cut through the “close the loopholes” garbage and hang tough on the tax rates.

The US tax code is a complex monster of individual and corporate income redistribution through tax expenditures, i.e., foregone tax revenues comprising: tax credits, deductions, exemptions, loopholes, capital gains … concessions that have long been a haven for special interests and a tax lawyer’s delight for clients in the top 1%, 5%, 10% income distribution groups. The Urban-Brookings Tax Policy Center concludes that in 2011 households with incomes in the top 20% received 67% of benefits from tax expenditures while the top 1% received 25% of these benefits.

Not surprisingly, the top 1% average federal effective tax rate fell to 23% in 2008 vs. 34% in 1980. The top 1% share of total income increased from 9% in 1970 to 23.5% in 2007 (vs. 11% Germany, 8.7% France and 5% the Netherlands), contributing to the US huge gap in income inequality in combination with stagnant middle class wages. Little wonder that between 1979 and 2007 average before tax income for the top 1% increased 240% compared to 20% for the middle fifth and 10% for the bottom fifth.

In short, the US has been redistributing income through forgone tax revenue benefits. This has led to very low EFFECTIVE tax rates largely benefitting the top income classes and corporations … much lower effective rates than those of the mature European countries. The latter redistribute their much higher progressive tax rate revenues and regressive VAT taxes more evenly across their societies through a wide range of social nets and public investments in transport, infrastructure, broad vocational and general education systems.

This has led to EU poverty rates and income inequality gaps of one-third or less of US levels. Historically, this has supported job stability and led to a pay system where the proportion of workers employed full-time and earning less than 65% of the median wage is one-half to one-fifth (Finland, Sweden) that of the US (from writings of economist Timothy Smeeding and Katherin Phillips). Of course, when times change or structural difficulties arise, I’ve seen firsthand over 34 years now how the mature EU countries generally always make the appropriate sensible but balanced, egalitarian adjustments to their tax, financial, and social systems … as is happening now in these very stressful economic times.

The macro-economic result of our messy, indecipherable tax system is that total US federal, state, and local taxes reached a low of 24% of GDP in 2009 vs. 30% in 2000. The system is a playing field for bought politicians and special interest lobbyists to manipulate to their heart’s content … thereby bringing federal tax revenues for individuals and corporations as a % of GDP to the lowest levels in decades. This is mainly due to layer upon layer of loopholes/special tax concessions, ridiculously mild progressive tax policies, lowering of individual and corporate taxes, etc.. If these are not vastly reduced or eliminated, they will become further entrenched and added to over time by the same greedy powers, self-interested parties who got them there in the first place.

SUMMARY:
Some ideal federal tax reforms would be to: greatly simplify the tax code by eliminating the maze of tax avoidance, credits and deductions; then adjust statutory rates to levels insuring that federal tax revenues will not be less than 20% of GDP; introduce more equitable tax progressivity; require a two-thirds legislative approval to add tax concessions, i.g., deductions, credits, exemptions, etc.

In a word, drastically SIMPLIFY, make utterly TRANSPARENT and HUMANLY FAIR the bylaws of a trully reformed tax code. The well-managed countries of Europe have tax code systems that meet these criteria … thus immensely improving their tax revenue collection and stability in normal and abnormal times! People here have come to accept higher taxes because they receive something visible back in return. The European tax system may not be totally transferable for some unique cultural reasons, but many components do apply … as Canada is also a good example of.

Frank, I like your idea of requiring two thirds legislative approval for any new loopholes after the tax code has been simplified. That way legislators could not simply add new loopholes as riders to other bills that they pass. However, depending on the makeup of Congress and the Presidency, future tax “reforms” could just do away with that requirement. Tht’s why I view any lowering of rates with suspicion.

Robert Kuttner in the Huffington Post published an article today with the same title as Krugman’s: “Let’s Not Make a Deal”. The main people hueing and crying about the fiscal cliff are mainly conservatives. It is really, as many have pointed out, a fiscal slope, not a cliff.

It contains $5 in tax revenues for every dollar in spending cuts. Republicans in their primary would not even give one dollar in tax increases for $10 in spending cuts. That’s why I argue that the provisions in the “fiscal cliff” actually favor Democrats and progressives.

None of the spending cuts are drastic except to defense, and, I would argue, an 8% cut in defense to a bloated military budget greater than the rest of the world’s military budgets combined, is not that drastic.

If you look closely at the guys running around with their hair on fire over the fiscal cliff, they are Republicans and conservatives.

To keep the economy from going into recession, the fiscal savings should be split evenly between deficit reduction and an infrastructure program.

“Obama is not in the mood to make the big concessions. Tax policy played a large role in the election he just won, and the fiscal cliff gives him some negotiating advantages. Even if tax rates go up on paper on Jan. 1, no one will lose money until April 15, providing a buffer. And while the sequester, or mandatory government spending cuts, will hit the Pentagon hard, on the non-Defense side, they will exempt 47 social safety-net programs, including Medicaid, child support and many other low-income benefits.”

My point exactly: 47 social safety-net programs are exempted from the fiscal cliff including Social Security, Medicare, Medicaid and Veteran’s benefits.

A decent infrastructure program combined with letting the fiscal cliff happen should stave off any recession and, more importantly, get our house in order and our priorities straight.

Also any “grand deal” should not decrease any Social Security or Medicare benefits. Raising the cap on income subject to Social Security and Medicare taxes (currently around $100,000.) should put those programs on an even keel.

Lowering of tax rates would be conditioned on: serious simplification of tax code; elimination and/or sharp reduction of tax expenditures (credits, loopholes, deductions, exemptions, etc.); reduction of tax rates only to a level that final federal tax revenue generation would meet 20% of GDP rule. The two-thirds legislative approval provision could be structured to apply also to any changes in the basic rule itself.

I know how cynical many, many well-meaning Americans have become about our political system’s ability to come together creatively and pragmatically to correct the flagrant social-financial dysfunctions hurting Main Street. One thing is certain …
continued ideological polarization and inflexibility lead to a Dead-End street.

In turbulent, divided times, constructive policy cooperation for the common good is the only answer … that “men of sound minds and honest views” unite to get control of climate-change disasters, unsustainable deficits and debt, and strike a deal to expand job generating and education investments that will make America stronger.

In pursuit of these awesome tasks, another thing is also certain … inadequate tax funding is the end of government.

I think Obama has to go all out to maintain that he wants to cut a deal involving restoring the middle class tax cuts and restoring the cuts in the defense budget before the deadline on the so-called “fiscal cliff,” but from a political point of view he would be much better off, if he doesn’t get the deal he wants, to let the fiscal cliff or, as many have called it, the fiscal slope happen because then the Republicans will come crawling to him on their knees to restore the defense cuts. The middle class will not be hurt that much by the tax increases especially because Obama will have a whole year to get a deal done that will lower them retroactively, but Republicans will be so hurting on the defense cuts.

Obama will have them where he wants them. He’ll be in the catbird seat. By all means, if he can get a really good deal before the fiscal cliff, then he should take it, but knowing the Republicans and their obstructionism and intransigence, it’s not going to happen. The only deal Republicans will be interested in is one that restores all the defense cuts and involves no tax rate increases.

Obama is in a good position now, but he’ll be in an even better one if he lets the fiscal cliff happen. Of course he can’t be seen as actually wanting that. He has to be seen as wanting the tax increases on the wealthy but no tax increases on the middle class, and wanting to cut a deal before January 1. But he will be in an even stronger negotiating position if there is no deal before January 1.

I heard a piece on the radio the other day that the “fiscal cliff” is the creation of Federal Reserve Chairman, Ben Bernanke, who managed to get Congress to pass these reforms almost as a dare from Bernanke for them to put their partisan bickering aside and reach a compromise that would lower the deficit and do it by a time certain, or he would do it for them, in the form of what he dubbed the “fiscal cliff”, so named by Bernanke explicitly to scare Congress into acting. The name was intended to scare politicians, not the public, who from media reports I hear, are giving the whole thing a big yawn.

As the story I heard on NPR goes, no one including Bernanke thinks for a minute that the country will curl up and die if these “austere” reforms occur, but rather that they will represent the beginning of the healing of the economy and better times ahead for all.

If indeed the consequences of the “fiscal cliff” are as you describe in the opening paragraphs of this blog, then then going over the “fiscal cliff sounds like the roller-coaster ride the economy needs.

My biggest fear if Congress does something, is that they will enact something that will allow them to claim to the media that they have averted the “fiscal cliff”, but be so paltry a reform as to completely fail to address the deficit. This would be a far worse fate for all of us then simply letting the medicine prescribed by Dr. Bernanke have its effect. Obama should hold a hard line against weak proposals from Congress designed to save politicians’ skin, but do little to rectify the problem.

Bernanke is the responsible party for coining the term “fiscal cliff.” If Obama and the Democrats indeed want to get serious about doing something about the deficit and get any kind of a deal to rebuild infrastructure, then they need revenues on the order of what the fiscal cliff will provide. If they want to dicker around the edges, so be it. Democrats have warmed to Romney’s idea of limiting deductions to say $17,000. I think this is not a bad idea – especially limiting them for the rich.

Me thinketh that Obama doth protest too loudly about raising middle class taxes back to where they were under Clinton which the fiscal cliff would provide. He’ll do everything he can to forestall this possibility, but if it took place, it would put the nation in an even better place than if the Bush tax cuts expired only for the rich.

Why the Republicans ever agreed to this fiscal cliff in the first place is beyond me. The deal so favors Democrats. There is a 5 to 1 ratio between money raised from tax increases to money cut from spending programs and those programs are mainly defense. Remember that all the Republican Presidential candidates would not even agree to a 10 to 1 ratio of spending cuts to tax increases.

If Obama makes a deal with Republicans over the fiscal cliff, it will be the last deal he’ll ever get for the next 4 years because they won’t support any of his initiatives just the way they didn’t support them for the last 4 years, and he’ll be truly a lame duck for 4 years. On the other hand, if he is willing to let the fiscal cliff happen in the case that he doesn’t get a very strong deal like an agreement for an infrastructure bank and restored extended unemployment insurance, Republicans will come crawling to him on their knees after January 1, wanting to “compromise” over restoring defense cuts.

He needs to use all the leverage he possible can muster over this fiscal cliff because if it’s resolved before January 1, he’ll never get any “compromise” again for the next 4 years. He needs to play the Republicans like they played him for the last 4 years. Only then will they be willing to negotiate – when they absolutely need him to get what they want.

Sorry to be Machiavellian, but look at what the Republicans have done for the last 4 years. They have thwarted everything Obama tried to do just to gain political power. In the end their Macchiavellianism didn’t work, thank God. That doesn’t mean that they have had a “come to Jesus” moment and now they’re good guys who just want to compromise for the benefit of the American people.

Obama needs to get everything that is on his agenda for the next 4 years as part of any fiscal cliff deal because, otherwise, he’ll never get those parts that are left out. It is within Republican power because they control the House and have filibuster power in the Senate to negate every single piece of legislation Obama proposes for the next 4 years. That’s why he must get everything now as part of the fiscal cliff deal because he’ll never get another chance to get anything.

I have thought for months that the fiscal cliff was best to just go over. I agree with you john that as usual the military industrial complex is COMPLETELY out of hand….wasting all of our resources on its own greed….. just saw that some super stealth fighter cost 400 million apiece that is for each one to produce I am surprised that any average American would put up with this Of course this would eliminate jobs from local and overseas bases but it needs to be done I did hear or read that most “in home” services would be eliminated from medicare Don’t know if this is actually true It will be worth the slight recession created to reduce our spending, have an icreased and fairer tax on the rich, and have a great impact on our debt. I agree with you an Paul Krugman Grace Rich

What the facts are surrounding the “fiscal cliff” (ie, what exactly will happen to the average middle income homeowner if the country goes over the “fiscal cliff”) is not clear. The answer seems to depend on who’s giving it. Today I heard that the average middle and low-middle income homeowner will take a $2000/yr tax hit. Is this true?

Thank you for your comments. I do think that a huge infrastructure initiative should be part of any deal Obama makes regarding the fiscal cliff. Not only is the US $2 trillion in arrears just on bringing existing infrastructure up to snuff, we need to go beyond that by creating a smart grid, smart houses that use less or even no net energy (they already have them in Germany).

Not only would this create jobs to offset job loss in the military-industrial complex, but it would set the stage for a huge renewal of small business and entrepreneurialism. Many in the military-industrial complex would gladly exchange their jobs for ones in an infrastructure-industrial complex. The creation of a Secretary of Business, as Obama has suggested, might be the beginning of a badly needed industrial policy in the US – one that would expedite and coordinate the efforts of the private sector and encourage exports.

Many have suggested that once the fiscal cliff has been gone over, Republicans would have a hard time resisting a bill that would restore the tax cuts for the middle class. Obama needs to be playing chess and not checkers over the whole situation because Republicans will not give an inch unless they are forced to by the American people and even by their own political interests. Obama needs to keep them over the barrel they now find themselves in. They have played Macchiavellian politics with him for 4 years. Let’s not forget that. They have not all of a sudden become Mr. Nice Guys.

Good to make your acquaintance again on Internet, Paul! Coincidentally, yesterday I was working on a detailed article exploring key avenues of the very question you raise. Hope following clarifies things a little more than it confuses!

Under current law, the federal budget deficit will fall dramatically in fiscal year 2013 and calender year 2013. Expiration of tax provisions such as those that lower income and payroll taxes and limit the reach of the Alternative Minimum Tax will expand tax revenues considerably. A May 2012 CBO analysis shows that “going over the cliff” in fiscal year 2013 will reduce the 2012 fiscal deficit of $1,172 billion by $607 billion including: $399 billion in tax revenue changes (66% of total) entailing mostly expiration of the Bush tax cuts and payroll tax cuts; plus $208 billion (34% of total) in spending cuts and other revenue changes.

Much to my surprise, the CBO’s estimate of the economic effects of the fiscal cliff appear less ominous on first glance. GDP growth will contract to an annual rate of 1.3% the 1st half 2013, recovering to 2.3% the 2nd half. The CBO expects that the added drag on the economy will lower taxable income, raise unemployment from 7.9% to 9.1% by year-end 2013 … generating a reduction in tax revenues and increased spending in such items as unemployment insurance amounting to a moderate, although perhaps optimistic, $47 billion.

So the net fiscal year 2013 effect is a $560 billion deficit drop to $612 billion or 4% of GDP in 2013 vs. a $1.172 trillion deficit or 7.7% of GDP in fiscal year 2012! This is a SUBSTANTIAL deficit improvement even if the $560 billion change is 10%-20% overstated! BUT, so much fiscal restaint coming so quickly does carry risks.

The CBO’s apparent “moderate landing scenario figures” of falling of the cliff is also implied by the independent Tax Policy Center (TPC). This study points to the $2,000 figure you mention, Paul. The TPC estimates that the overall effect of “going over the cliff” would cost about $3,500 per household comprising: (1) $2,000 for a middle income family; (2) $120,000 for top 1% average household; (3) $400 for an average low income household. This doesn’t exactly seem like the end of the world to me, but again there are other risks.

The risk of such an aggressive and abrupt fiscal restaint is that too much too soon could trigger a European style recession leading to a return to ever more stimulus spending and tax cuts, thus reducing the CBO estimated $560 billion deficit improvement in the short term. Going too fast now by applying the full measure of fiscal cliff restraint in 2013 may be unwise when our economy appears on a slow but steady climb upward both in growth and jobs.

On the other hand, cutting spending and increasing taxes too slowly will lead to a greater accumulation of debt and interest. Besides reducing national savings, large budget deficits and increased debt restrict government’s ability to respond to economic downturns, environmental, and international crises. There’s also the risk of our bonds being downgraded with resultant growing inability of the government to borrow at affordable rates.

The above risk is compounded by a decades long tax code filled with loopholes and deductions. In my view, the latter create a much greater loss of tax revenues each year than recognized … especially when tax haven avoidance and lack of a financial transactions tax are taken into consideration to stabilize speculation and obscene profits. But simplifying the tax code will take time to get the right negotiated balance between elimination of loopholes, tax avoidance, and deductions versus tax rate changes. Of course, the Republicans seem obsessed to simplify the tax code in order to sharply lower tax rates, social nets, and thus the size of government. It’s part of the “anti-government” cult disease infecting our democracy.

That needs to be avoided at all costs. It is why I feel equitable reforms in tax rates as a result of tax code simplification should generate adequate revenue to cover at least 20% of GDP. And it is also why I believe any proposed legislative changes in later years to any tax code simplification in 2013 would require a two-thirds majority. This provision would apply also to new legislation desperately needed that sets reasonable but firm ceilings on annual federal deficits and public debt as a percentage of GDP … as all the EU countries have accepted.

In forgot to conclude that I totally agree with John and others that Obama should stand firm on the so-called fiscal cliff problem. Let the fall take place for the period it takes in 2013 to come up with a sensible compromise on short and long-term moves to deficit and debt reduction. This means accepting on an interim basis that this delay may negatively affect corporate plans to hire , investor plans to invest, and consumer plans to buy.

Putting budget policies on a sustainable path that restores trust and confidence will require time as this involves significant, fundamental changes in spending policies and tax policies. Hope we don’t resort to usual band aid approach to deep structural problems that are undermining our economic system.

I hope Obama doesn’t fall victim to the GOP “charm offensive,” such as it is. Boehner, McConnell et al said their meeting today with Obama was “constructive.” Regardless of his outward demeanor, Obama needs to drive a hard bargain and not settle just for some presentable solution. He needs to play chess and look a few moves down the road. These guys will try to get off the hook with the minimal hardship for those they represent, namely the upper 1%.

The projected 2013 fiscal year deficit of $612 assumes the full fiscal restraint measures under current law are not changed in any way. Here’s the Congressional Budget Committee´s specification of the change in the budget deficit from revenue and spending policies and from economic effects between the fiscal years 2012 and 2013:
($BILLIONS)
Deficit in 2012 $1,172 = 7.7% of GDP
Deficit in 2013 $612 = 4.0% of GDP

If the result of “going over the cliff” or “sliding down the slope”, or whatever you want to call the congress and the president’s failure to enact deficit-reduction legislation, your data Frank and your comments John, both seem to be saying, unless I’ve misconstrued you, that the middle class will not suffer dramatically and will actually benefit in the long term by the reduction of the deficit that will gradually occur as a result of the automatic cuts and tax increases that will occur.

If this is so, then why do I keep hearing and reading media reports of the opposite. Such as, 45,000 recipients of unemployment in MA will immediately lose their unemployment benefits in Q1 of 2013, the average middle class family will see a 1-year tax in crease of ~$2000 in 2013. These are big hits in the short term. Are they just not true, or what?

Paul,
It’s true about people losing their extended unemployment. That in my opinion is the worst aspect of the “fiscal cliff.” As far as taxes being raised on the middle class, this will happen gradually not in one fell swoop. I think the middle class and specifically the ones with jobs should thank their lucky stars they have a job and be willing to pay a little more along with the wealthy who will be paying a lot more. After all the middle class paid these same tax rates during the Clinton admistration with seemingly no terrible consequences. If they have to hunker down a little to get the country on a sound fiscal footing, so be it.

And once the fiscal cliff has been gone over, negotiations do not stop there. I would anticipate that the Obama administration and Congressional Democrats would go to bat to get the extended unemployment insurance reinstated and also to reduce taxes on the middle class. At that point Repubs will have a lot of incentives to negotiate in my opinion.

Also the $50 billion Obama wants for infrastructure will offset the tax inceases as it will create a lot of jobs.

Is it really that important that the middle class be able to consume $2000. more of crap imported from China compared to the creation of new jobs, cutting the military-industrial complex down to size and pretty much eliminating the deficit? I think getting the country on not only a sounder financial footing but also on a sounder moral footing is worth it.